Author: bestweb1

Department of Labor

A representative of the Department of Labor issued a statement this Tuesday concerning the much debated and watered down version of a proposed ERISA rule regarding a requirement for plan “advisors” to act with fiduciary care and obligation when selling . . . uh, excuse me, . . .”advising” investors concerning their employee retirement plans and IRA accounts.

Originally published on July 17, 2015

‘We aren’t wedded to any particular choice of words or regulatory texts,” Timothy D. Hauser, a DOL deputy assistant secretary, told a meeting of the Securities and Exchange Commission’s Investor Advisory Committee. “The point is to improve this marketplace, not to defend the details of our package. There will be changes – no doubt about it.”

Not surprisingly, the DOL continues to get significant pushback from industry heavyweights in the insurance, brokerage, and mutual fund industry. This has been an ongoing battle since the first proposal in 2010 and a subsequent study by the SEC, ordered pursuant to the Dodd-Frank Act. The following link is a fact sheet that describes the problem and the current proposed solution.

I’m not a big Obama fan, but I appreciate his stance on this issue. You decide which side you are on.

Since the DOL invited public comment on the issue, I shared my view.

Ladies and Gentlemen,

I applaud the spirit and intent of the proposed rules regarding the fiduciary standard concerning retirement plans. I also understand why you are getting a lot of resistance from the big industry players.

Most of the investing public does not know what “fiduciary” means. However, they think their financial advisor is obligated to look out for their interest and trusts him/her to do so. They assume that whoever they decide to trust has the burden of fiduciary care. The industry marketing machine promotes this false sense of security with billions of dollars of TV and internet promotion designed to do just that.

The issue at hand is the public’s understanding of fiduciary vs suitability obligation and who is held to what standard. The public deserves to know whether they are being served or sold by their financial advisor. Under current rules, most representatives of the commission-based brokerage and insurance industry are dually registered. They are licensed and registered as an insurance agent, a registered representative, and an investment advisor representative. According to agency law, the insurance agent and registered representative both have a legal obligation of loyalty and service to their employer or principal (not their clients), and are trained, motivated, and compensated to sell products.

An investment advisor, according to the Investment Advisors Act of 1940, has a legal obligation to always serve/act in the best interest of the client. As such, charging a commission on product sales creates a direct conflict with clients’ interest. Clients have no way of distinguishing between advice and a pitch. The industry has perpetrated a great deception against the investing public by allowing dually registered sales reps to masquerade as advisors to build trust for the purpose closing the sale. All that is required to mitigate the conflict of interest is that the agent disclose that they are getting a commission from the sale of a product. The required disclosure doesn’t include the dollar amount they are paid and is usually buried in the mountain of paperwork that nobody reads.

The majority of successful “advisors” are honest, hard-working folks who just want to make a living helping people. However, sales reps are indoctrinated by the industry and led to believe they are serving their clients best interest by selling the most expensive products. At the same time, seventy-five to ninety percent of reps struggle to meet quotas much less earn bonuses. That is what is required to keep their job, move up the career ladder, and get paid. The vast majority of the training received by sales reps is on leveraging the company’s brand, their credentials, and their personal relationships (brother-in-law, college buddy, neighbor, church members) in order to achieve “trusted advisor” status without actually being required to perform in that capacity.

You will not resolve this issue by creating legislation to make a wolf treat its prey more fairly. I know that sounds like a harsh analogy, and very few commissioned sales reps see themselves in this light. However, if a representative is dually registered and is selling products for a commission, he is deceiving himself and his clients if he thinks commissions have no influence on advice.

The best solution to this issue is to disallow dual registration. A representative is a fee-only fiduciary or a commissioned sales rep. He/she can’t be both. The next step is to require all market participants to clearly state their legal obligation in all advertising, marketing, and promotional material. Finally, any RIA that sells a commission based product should clearly state in a separate printed document (not bundled with the mountain of contract paperwork), the nature of the conflict of interest and the amount of the commission that the advisor and its representative(s) will receive if the client purchases.

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If you are going to put your life’s savings into mutual funds (most of middle America does), you need to know what’s under the hood.

Invest ten minutes reading this article and you will know more about mutual funds than most of the people selling them.

In the next few minutes we will explore a minute core of the history and evolution of mutual funds, then focus on the fundamentals that are most important to the average investor.

The origin of the mutual fund can be traced back to 17th and 18th century Europe, where the concept of pooling assets was popularized by the Dutch as a means to raise capital for merchant ventures. It provided diversification for investors, and opportunities for smaller investors to participate in ventures. By the mid-nineteenth century, closed end funds had spread to Great Britain and France, taking root in the US in the 1890s.

Prior to 1929, there was no regulation of the securities industry. Companies needing capital issued stock. Brokers sold the stock to investors, often making wild claims and unsubstantiated promises of big profits. Investment companies packaged the stocks from many companies and sold them as mutual funds, often borrowing money from banks (leverage) to purchase more shares than cash raised from investors would allow.

By 1929 there were nineteen open end funds competing with nearly 700 closed end funds. Many of the highly leveraged CEFs were wiped out in the crash of 1929. Open end funds generally offered semiannual share issuance and redemption opportunities and therefore were not highly leveraged as closed end funds were. This also created better liquidity for investors and infusions of cash to keep the funds afloat. This is the form that the retail mutual funds of today operate under.

The stock market crash of 1929 spurred sweeping legislative reform of the securities industry over the next eleven years. Major legislation included;

By 1954, the financial markets had recovered from the crash of 1929. Mutual funds continued to gain popularity. However, it was the creation of the 401k, conceived in 1980 by Ted Benna, then an employee of the Johnson Companies, and now president of the 401k Association, that really set the stage for today’s massive expansion of mutual funds as a “trusted” investment vehicle in the American consumer’s collective consciousness.

In the 1970’s, 80’s, and 90’s, corporate America was facing a huge and growing commitment to pension plans that were crippling profitability. People were living longer and drawing pensions for 30 years or more. At the same time top level managers were trying to figure a way to sock away more compensation for themselves. Enter Ted and his great idea. Rule 401k of the existing IRS tax code gave big companies a tax break for offering a savings plan for employees, but very few took advantage of it. Benna suggested, “why don’t we offer a matching contribution?” The rest is history.

Corporate plan sponsors were anxious to get out from under the cost and fiduciary obligation for their retirement plans, creating a huge opportunity for bundled investment and plan solutions. Investment companies quickly stepped up to the plate with mutual funds. This coincided with the bull markets of the 80’s and 90’s so the investment companies also found a ready market for 529 college savings plans as bull market inflation caused college tuition and other related costs to soar.

According to Jack Bogle, CEO of the Vanguard Group, “around 7 percent of mutual funds “died” each year between 2001 and 2012. That’s up from about 1 percent per year during the 1960s. Assuming (as I do) that such a failure rate will persist over the coming decade, some 2,500 of today’s 4,600 equity funds will no longer exist.” You would think that at that rate mutual funds would disappear from the market. However, new funds come on the scene faster than they are dying. Despite the 2003 mutual fund scandals, the global financial crisis of 2008-2009, and ongoing revenue sharing practices, the story of the mutual fund is far from over. As of this writing, there are about 10,000 mutual funds on the market, including the equity funds Jack spoke of.

What, exactly is a mutual fund. It is a collection of exchange traded securities (stocks, bonds, REITs, business development companies, etc.) that meet the stated portfolio objectives defined by the investment company and fund manager. It allows an individual to pool a small amount of money with other small investors to own shares of the fund, which owns a large number of securities.

What is the primary advantage of a mutual fund? – A mutual fund provides diversification for investors who can’t afford to own a diversified portfolio of individual exchange traded securities. For example, at the time of this writing, Google sells for over $500/share. IBM and Apple both sell for over $100/share. The minimum purchase unit for most corporate and municipal bonds is $5000. In order to create a diversified portfolio of 60% individual stocks and 40% individual bonds, an investor would need to invest between $100,00 and $200,000 to get started.

What is the primary disadvantage of a mutual fund? – Retail mutual funds have sales charges, administrative fees, and distribution fees associated with them that add substantially to their cost. The fee structure is very complicated by design. Retail funds are sold by brokers who’s primary loyalty and legal obligation is to their employer, not their client. Revenue sharing, described in a link above is still practiced by all of the major brokerage firms today. The required disclosures are buried in websites with no links to them or the 300 page electronically delivered fund prospectus. Many investors have twenty or more mutual funds in their investment portfolio, significantly over diversifying and diluting the benefit of superior stock or bond performance.

The following is a breakdown of the most common share classes, their approximate costs, and the rules of play your broker is supposed to abide by. This is part of the actual required disclosure statement for one fund that belongs to a popular fund family. Its sales charges and fees are about average. Other funds’ expenses will be higher or lower than this one.

If you buy A shares, you should make all of your fund purchases inside one fund family, and be absolutely sure you are not paying advisory fees on top of the commission. For example if you are a long-term investor and want to buy the XYZ Growth Fund, you should buy only funds from the XYZ Fund Family. The more you buy, the lower your sales charge is. Once your account reaches $1,000,000, you don’t pay any sales charge for additional investments. However you still pay .95% in annual fund expenses. This is the least expensive way for a disciplined investor to buy and own mutual funds. The rules say that your broker has to wait at least two years to sell those funds and replace them with funds from another fund family, thereby collecting another 5.25%.

B shares have no up-front sales charge, but have a higher 12b-1 fee than A shares for the first six years and a declining back-end sales charge (CDSC) to get out of the fund. After that it converts to an A share.

C shares are sold by broker/advisors that sometimes charge a fee on top of the 1% distribution fee. Both the advisory fee (up to 2%) and the the distribution fee (in this case 1%) are generally shared by the brokerage firm and the advisor for as long as the fund is held.

I shares (institutional) may be sold by fee only or fee based advisors. Most advisor fees will range between 1% and 2%.

R shares, A shares, C shares and sometimes I shares are used in 401k plans. Very often there are multiple classes of R shares (R1, R2, R3, R4, R5) with different distribution charges to accommodate the transfer of employer costs for operating the plan (TPA and other administrative costs) to employees and pay the broker who sets up the 401k.

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The Social Security Administration estimates that 96% of American workers are or will be eligible for Social Security retirement benefits.

However, many Americans approaching social security retirement age don’t have a full understanding of benefits it provides. Many people are not aware that:

Social Security is currently the largest social insurance program in the U.S., funded through dedicated payroll taxes called Federal Insurance Contributions Act (FICA).

If a contributor is injured or becomes ill and cannot work, he/she may qualify for disability benefits.

If a contributor dies prior to retirement, certain family members may be eligible for survivor benefits based on their work and earnings record.

A divorced spouse may be eligible to draw retirement benefits based her ex-husband’s contributions even if he has remarried and is already taking benefits himself.

The Social Security retirement benefit is designed to replace a percentage of earnings at retirement and the amount received will depend primarily on two factors…lifetime earnings history and retirement age.

Depending on year of birth, taking SS retirement benefits early can result in as much as a 30% reduction in the retirement benefit that would be payable at full retirement age.

On the other hand, deferring Social Security retirement benefits to age 70 can result in as much as a 32% higher retirement benefit as compared to the benefit available at full retirement age.

A portion of the Social Security retirement benefit may be subject to income tax.

There are a variety of strategies that can be used to enhance the value of Social Security retirement benefits, and minimize or eliminate income tax on social security benefits.

Beneficiaries who are eligible for the maximum social security benefit leave as much as $175,000 in lifetime benefits with Uncle Sam by taking benefits early (age 62).

For most people, their monthly Social Security check will form an important part of their retirement income.

If I were handing over my life’s savings to someone else to manage, I would like to know as much as I can about that individual and the company he or she works for. You should too. In the next few paragraphs, we will explore how to choose a financial adviser based on the issues that matter most. Thanks to modern technology, everyone has instant access to the greatest investigative tool on the planet, . . . the internet.

Every major financial services organization out there spends an incredible amount of money ($billions$) on marketing and sales training to make your decision about who to hire an emotional one rather than one based on facts and logic. Sales reps are trained to believe they have the very best products in the industry, that they have an incredible marketing and ethical edge on their competition, and an obligation to share this new-found opportunity with people they care about. First contacts (sometimes even before licensed) are always family, friends, neighbors, and church members. The company trains representatives to rely on the emotional bond with the prospect rather than the relative merits of the products or strategies they are pitching. The company trains “advisers” on how to build and manage relationships, gather assets, and sell products, not how to best serve their clients.

We all want to do business with people we know and trust. But there is nothing more disappointing than being misguided by a family member or close friend. If you want to be confident in your adviser decision, do your homework.

The first step is to check out your financial adviser. Regardless of how well you think you know the person or how reputable you think the firm is that he/she represents, you need to check them out before you commit. Obviously, he/she needs to have credentials or education that qualifies them for the work they are doing. The industry is awash with credentialing organizations whose primary business is making salesmen look like they know something. The most prevalent and reliable is the CFP designation. Even the CFP can be earned with a $2500 fee, six months study, and passing grade on the exam. A four year bachelor’s or advanced degree in finance from a credible institution plus extensive industry experience (ten years or more) is much better. Check out his or her standing in the industry (regulatory action, civil suits, jail time, firms he/she has associated with, etc.) at FINRA’s broker check. Don’t stop there. Do a local search in google by typing “adviser first and last name” + “your city and state” in the search window. If he/she has been around a while you should find lots of local references.

The next step is to check out the firm your adviser represents. Again, google is your best tool. Type “firm name” + litigation in the search window. Be prepared, almost every major name in the financial services industry is covered up with lawsuits. Their representatives are coached on how to field inquiries, but the fact remains that these suits are brought and judgments are levied because they are very likely breaking the laws that were put in place to protect you! Find out if they dual register their advisers as registered representatives and investment adviser representatives.

The root of most complaints is breach of trust. Someone you trust sells you something you don’t understand is not in your best interest. This occurs often due to the widespread practice of dual registration or the “hybrid RIA”. Big firms will try to make a distinction between the two as a smokescreen, but its still the conflict of interest that is at the core of the problem. A registered rep. or insurance agent is a salesman whose loyalty and obligation is to their employer. A Registered Investment Adviser has a legal fiduciary obligation to his/her client. Obviously, these are competing agendas. You can be an adviser or a salesman, but you can’t be both.

While the internet is a great investigative tool, you still have to exercise common sense and good judgement when evaluating information that you find. If you do a search on “hybrid RIA” or “dual registration”, you will find articles geared mostly toward advisers who are considering a career change. The industry promotes this business model very positively and makes it sound very attractive to recruits without setting off an alarm for other readers. However if you do a search on “suitability vs fiduciary” you will get a very different and more realistic view of how most firms abuse the law, claiming to adhere to a high standard of trust in order to lower the consumers guard when selling products.

Most folks who’ve heard of the ROTH IRA think they already know everything they need to know about it, i.e. “It’s boring and doesn’t deliver the immediate tax deferral of a 401k or traditional IRA.” True, setting up a ROTH IRA won’t make anyone rich. Like any other tool, it’s only as good as the strategy or plan behind it, which is why I’ve listed below some of the little-known features of the ROTH that make it a super-tool for building tax-free wealth. However, like any valuable tool, it’s how you implement these features that make it powerful! The key to realizing the benefits of a ROTH is to be intentional about strategy, design a plan that best suits each client, and remind them regularly how and why we did it.

Anyone with earned income (adjusted gross income up to $181,000 for couples filing jointly or $129,000 for singles) can contribute to a ROTH even if you have a 401k or pension with your employer. This can be W2, 1099, or self-employment income.

You can contribute 100% of earned income up to a maximum of $5,500 per year or $6,500 per year for anyone over age 50.

A ROTH is an individual account, so the limits for a couple would be $11,000 and $13,000 per year respectively.

Contributions are made with after tax income, so there is no immediate tax benefit. However, earnings from dividends, capital gains, and interest are tax free.

You can continue to make contributions after age 70 ½ for as long as you have earned income. Contributions must stop at that age for traditional IRAs and as well as for other tax deferred accounts, such as 401k, Simple IRA, or SEP .

There are no required minimum distributions at any age for a ROTH (for the original owner). You must begin taking required minimum distributions from a traditional IRA or other tax deferred accounts at age 70 ½.

Earnings from interest, dividends, or capital gains are effectively tax free forever, even to heirs. Caveat – earnings distributed before age 59 ½ or earnings on assets in the account that are less than five years may be subject to a 10% early withdrawal penalty. However, all distributions are taken contributions first, so there is rarely a penalty assessed on any distributions.

You and your heirs can take distributions from a ROTH tax-free and with no penalties at any age. Your designated beneficiary (if other than spouse) must take minimum distributions based on their life expectancy. Create a tax-free college (or any other use) fund for grandchildren. This can work for multiple heirs if structured properly.

Distributions from ROTH accounts do not count against MAGI (modified adjusted gross income) for calculating taxes on Medicare surcharge tax (for higher wage earners, greater than $125k single or $250k married filing jointly) or Social Security income tax. This is a huge and very often overlooked benefit of ROTH IRAs. Not even tax-free municipal bonds provide this benefit.

Any tax deferred retirement account (IRA, 401K, SEP, Simple, some other deferred comp plans) can be converted to a ROTH IRA. To convert an employer sponsored plan, the client must first be separated from the employer that sponsored the plan, then do a tax-free direct rollover to a traditional IRA. Any amounts transferred from a previous employer into a current employer-sponsored plan are eligible to be transferred out to a direct rollover IRA. Once the funds are in a rollover IRA, they can be converted and transferred to a ROTH account. Consolidating old employer-sponsored plans to a single IRA gives the investor more control and generally creates an opportunity to reduce costs from internal management fees. This intermediate step is not always required. It depends on the policies of the sending and receiving institutions. Once this is accomplished it’s generally better to convert the big IRA to a ROTH a little every year so as not to push the client to a higher tax bracket.

Illustration: A disciplined 45-year-old couple earning household income of $85,000 a year rolls a total of $200,000 in employer-deferred comp plans (401k) into two IRA accounts, then converts them to ROTH accounts over a five year period to minimize the tax consequences. This increased their effective tax rate from 8% to 14% for federal and state taxes for the five year conversion period. Their effective tax rate is relatively low because they have significant mortgage interest and four dependent children. The total difference in tax liability experienced during the five year conversion period is $53,500. They paid $53,500 more in taxes during that time than they would have if they left the money in the traditional IRA.

$85,000 x .08 = $6,800

$125,000 x .14 = $17,500

5(17,500 – 6800) = $53,500

They paid the taxes due at conversion every year from funds outside the IRAs to avoid the 10% penalty for removing those funds before age 59 ½ and to leave more money inside the tax-free vehicle to compound over time. Neither of the clients have pensions, so they are depending exclusively on Social Security and distributions from retirement accounts to fund retirement. The couple decides to continue working and postpone filing for Social Security benefits until full retirement at age 66. The compound annualized growth rate (CAGR) for the S&P 500 over the past fifty years, adjusted for inflation, is 6.04%. Over the last ten years it has been 5.58%.

If we apply an inflation adjusted CAGR of 5% to the starting balance of $200,000, over the next 25 years they will have $677,271 when they begin retirement, assuming they make no further contributions. If they contribute $5000 each to their ROTH accounts every year until retirement, they will accumulate a total of $1,178,405. Keep in mind that these are inflation adjusted dollars. For the purpose of the illustration we will assume that the couple’s real earnings (adjusted for inflation) peak at $170,000 in household income at age 66 and base their Social Security income in retirement on that figure. Because we are using inflation adjusted dollars for everything else, we can use current estimates for household Social Security income in retirement. Estimated monthly household Social Security benefit in retirement is $2148 x 2 = $4296/month.

So…. let’s take a breath and see where we are. We know the following about our clients at age 66 and they are about to retire.

They have a tax free retirement nest egg of $1,178,405.

They have paid off their mortgage and no longer have kids to support or claim as dependents (fewer tax deductions).

Medical expenses may be higher but are now subsidized by Medicare.

Immediately before retirement, our couple has become accustomed to living on $170,000 annually net of federal, state, FICA taxes. FICA is 6.2%, effective combined fed and state is 22%. Total annual tax liability is 28.25%. Annual net is $121,975.

Our couple is willing to make minor lifestyle adjustments to ensure that they don’t outlast their money and to leave a tax free legacy for their grandchildren. They decide they will find a way to live on $115,000 per year or $9,583/month.

Our couple will be getting $4296 in social security benefits, so they will need to take $5287/month from their ROTH accounts. $9583 – $4296 = $5287.

For simplicity, we will allow our couple a long and happy retirement. Simplified average life expectancy for men is age 83, for women is age 86. They both die in their sleep at age 85, enjoying 19 years doing all the things they dreamed of. . . . all tax-free.

Since ROTH distributions are tax free, they don’t count as income for Medicare surtax or federal income tax on Social Security income. Additionally, SS benefits are exempt from state income tax in Alabama.

If our couple had taken distributions from a traditional IRA or 401k, their effective tax rate on distributions would be 19.45% (higher than the 14% during conversion period) and 85% of Social Security income would be taxable at 14.45%. This would have created an annual tax liability of $19,557 or $379,183 over the entire 19 years of retirement. Our couple incurred a $53,500 tax expense during the IRA conversion period in order to save $379,183 in taxes during retirement.

Now, after 19 years of tax free retirement, our couple left a $988,171 tax free inheritance to two children and three grandchildren that did not count as part of the estate for gift tax exemption. While the beneficiaries will have to take RMDs (required minimum distributions) based on their life expectancy, it will be significantly less than the anticipated compounded annual growth rate of the accounts, particularly for the grandchildren.

This is only one illustration of the potential benefit of a ROTH IRA as a tool in retirement and estate planning. But of course, there are several obvious caveats:

The clients must understand and adhere to the plan.

There may be other strategies that are more appropriate in a given real case.

We don’t know exactly what our Social Security or tax system will look like in 40 years, therefore any strategy must be adaptable to change.

For simplicity, we didn’t include a comparison of after tax vs tax deferred annual contributions to ROTH vs traditional IRA accounts.

So here are the important takeaways:

Many of us and our clients will be responsible for funding our own retirement. Pensions are disappearing.

Many clients are likely to have a higher effective tax rate in retirement than while working, particularly early on in work life.

Most notable and often overlooked advantages of a ROTH are Social Security and estate tax exemption in retirement distribution and wealth transfer described above.

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Not mentioned above, but clients with substantial carryover business or capital losses are exceptionally good candidates for ROTH conversion regardless of age.

All retirement accounts (including Roth, Traditional IRAs, SEP, Simple IRA, 401k, etc.) are simply containers for investments, not investments themselves. Mutual funds, annuities, and alternative investments can be held inside IRA accounts, but generally have fees, expenses, and lack of transparency that can significantly impact your return and the effectiveness of any strategy you use. Individual stocks, bonds, and other exchange traded securities, when properly deployed, provide the lowest cost and most effective investment vehicles.

What’s the difference between fiduciary vs suitability standard of care? Its a legal battle that’s been going on since the recent debt crisis and involves the single most important criteria you should consider when choosing an adviser to help secure your family’s financial future. Who should you trust?

A fee-onlyRegistered Investment Advisor(fiduciary) is legally obligated to put your interests before all others (including himself). The client and his/her needs are at the center of the relationship. The fee-only RIA does not sell products. Fee only advisers are usually experienced veterans of the industry who have opted to swim upstream against the industry norm, refusing to sell retail mutual funds, annuity products, life insurance, or any other commission based products that create a conflict of interest between them and their clients. Fee-only advisers often have all the licensing and credentials of their commission based counterparts, but are paid by you and serve only you with conflict free advice and portfolio management services.

Everybody else (suitability) is legally obligated to put their employer’s interest before all others, including yours. The employers’ objective is to sell financial products. All of their marketing resources, sales training, career incentives, and compensation system (commissions) are created and strategically aligned to sell products, not serve clients.

Why does it matter? The vast majority of the big name players in the financial services industry (brokers, banks, and insurance companies) will say it doesn’t matter, . . . that requiring everyone to meet a fiduciary standard of care will “deprive the investing public of flexibility in their investment choices”. Whut. . . ? And why shouldn’t they? Collectively, they spend billions of dollars a year on marketing materials, TV/WEB advertising, and sales training for the primary purpose of building trust. Once you trust the company, agent, adviser, sales rep., you willingly become dependent on him/her for financial “advice” and and generally follow it (ie., buy whatever they are selling). Their “advice” is a carefully scripted, multi-step sales process supported by bright colorful “financial illustrations” created by the multi-billion dollar sales machine described above for the exclusive purpose of generating revenue from commissions.

The Problem

Most people think their advisor is a fiduciary. Aside from the usual son-in-law, uncle, college buddy, golf partner, or good ole boy bias that that often precedes the financial adviser relationship (sales training), most people tend to mentally assign the characteristic of fiduciary responsibility to anyone they have decided to trust with their money, whether that trust is misplaced or not.

To further muddy the water, the marketing benefit of being able to claim fiduciary obligation while side-stepping the responsibility for it is not lost on the industry marketing machine. Many RIA firms routinely call themselves “fee-based” advisers and still sell retail mutual funds, annuities, life insurance, and all the other commission-based products, skirting the fiduciary responsibility by disclosing the conflict of interest. That disclosure is sometimes verbal, but most often is buried in the mountain of paperwork that nobody reads and is usually referred to by the adviser as “bedtime reading material”. Almost all of the big brokerage firms have an RIA subsidiary. Sales reps are dually registered as IARs (Investment Adviser Representatives), RRs (Registered Representatives), and are appointed as agents of the insurance companies that the broker dealer has selling agreements with.

The following is a short video that describes the issue very well.

[fvplayer src=”http://youtube.com/watch?v=Dg5RRMAc1GY”]

Many financial products serve a valid purpose for investors and everyone needs to manage risk. Sometimes risk is most appropriately managed with insurance products, but often is is not. Pros and cons of mutual funds, annuities, and life insurance is a subject for another post.

Be a hero this tax season! Taxpayers depend on their CPAs and attorneys to offer advice when they need it. Below are some “under the radar” ideas for tax reduction, retirement, and estate planning. If you come across a client who might benefit from anything listed below, include a very short handwritten suggestion with their return, send them an email, or make a short phone call. Even if they don’t act on it right away, it shows you are actively looking for ways to help them and will strengthen your relationships. Its the best five minutes you will ever invest in client retention.

ROTH IRA – The Super tool – In addition to commonly known benefits, the following can make sense for some clients.

Distributions from ROTH IRAs are excluded from MAGI (Modified Adjusted Gross Income) calculation for computing tax on Social Security benefits or new Medicare surtax.

No RMDs for self or heirs, distributions are tax free for self and heirs (some restrictions).

Owner can contribute and earnings grow tax free (capital gains, dividends, & interest) as long as he/she is receiving earned income (W2 or 1099) regardless of age.

Traditional IRAs can be converted to ROTHs a little every year so as not to increase marginal tax rate. Best to use funds outside account to pay taxes. Best used when business or farm losses already have client in lower tax bracket and qualified plan distributions in retirement would substantially increase marginal tax rate. Not always a good strategy, but future ROTH distributions are tax free and excluded from MAGI for social security taxation.

Young taxpayers are likely to be in higher tax bracket in retirement than they are now.

Full or partial 401k rollovers – Many clients aren’t aware of the benefits of rolling 401k plans from previous employers to an IRA.

Eligibility for early distributions before normal retirement age without penalty using SEPP (substantially equal periodic payments) 72t rules.

Funds rolled into current 401k from previous employer plans are generally eligible for rollover to new traditional or self-directed IRA.

Some 401k plans allow partial rollover (employee contributions) to IRA after age 55.

Tax advantaged public securities in non-qualified accounts.

Exchange Traded Master Limited Partnerships, Limited Liability Companies – Around 150 of these companies are traded on various exchanges. Generally 20% of distributions are taxable in the year received, 80% is deferred and characterized as return of capital reducing cost basis per share. Distributions are generally 100% taxable when cost basis is reduced to zero. Distributions characterized as return of capital are excluded from MAGI calculation for social security purposes. Heirs get step-up in cost basis when owner dies. Step-up means the cost basis is reset to current market price on the date of owner’s death, effectively resulting in no capital gain if liquidated.

Municipal bonds – Diversified portfolio of selected short to intermediate term hi-yield (4%-5% coupon), or low cost muni ETF (Exchange Traded Fund) can counter overall portfolio volatility and generate tax free income. Income in excess of MAGI limit may be taxable. Muni generated tax-free income is not excluded from MAGI calculation for SS purposes.

Some types of annuities offer distributions that are partially characterized as return of capital which is excluded from MAGI calculation for SS purposes.

A chainsaw is a very effective tool in the hands of a professional woodsmen, but can be dangerous for a novice. The tools above are those I use every day to serve my clients. CPAs and attorneys are in a particularly advantageous position to add tremendous value to client relationships by helping to reduce their pain and anxiety during tax season. Mention in your note that you know someone who can help if they want to learn more.

Electing your Social Security income benefit may be the most important financial decision you make in your lifetime. Retirees can miss opportunities to collect hundreds of thousands of dollars of additional income over their lifetimes by making poor Social Security income election decisions. By applying little-known yet creative claiming strategies, you may be rewarded with significant additional retirement income over your lifetime.

A multitude of possible combinations are available for choosing your Social Security income election. At first glance the election process and strategies can seem complicated and confusing. There are literally hundreds of strategic combinations for maximizing and optimizing your lifetime Social Security benefit. Unfortunately, few financial professionals understand how to successfully navigate the Social Security income election waters. Furthermore, only a small handful of diligent retirees investigate this critical financial decision at a deeper level.

Maximizing your Social Security income benefit requires a bit of education, good planning, and the application of smart decision tools. In this snapshot report, we highlight six important tools (i.e. concepts and techniques) pre-retirees and retirees should consider utilizing when evaluating their Social Security income claiming decision.

Tool #1: When You Claim Social Security, Get it Right the First Time

The Social Security Administration implemented a very important rule change, effective December 8, 2010, that places a limited timeframe constraint for when you can fix and re-do your Social Security Income election. You now have only 12 months from the date you file your claim to choose a more favorable election method.

Prior to December 8 2010, anyone who had been receiving Social Security income, regardless of when they filed, could pay back the income they had received and re-elect their Social Security income choice. Effectively, these folks were receiving an “interest-free” loan from Social Security, and the government decided to put an end to this loophole.

What does this important ruling mean for you? You should now be more diligent than ever when choosing how and when to take your Social Security income:

If you have made your income election within the past 12 months, you should consider reviewing it closely with a qualified Financial Advisor. You may still have time to re-file if another strategy is a smarter choice.

If you are about to file a claim, be sure to evaluate your benefit election options thoroughly.

If you make a mistake, or if your financial picture changes, you now have only 12 months from your date of election to change it.

In summary, it is now more crucial than ever to claim your Social Security income correctly the first time.

Tool #2: Understand the Impact of Claiming Social Security too Early

Research studies indicate about half of all Americans file during their first year of eligibility—typically age 62. Unfortunately, for a good portion of these folks, this could be a costly mistake. Filing early could mean forgoing thousands of dollars, and in some instances (especially with couples), over a hundred thousand dollars of their total lifetime income stream.

Although you certainly can file at 62 for benefits, most Americans will obtain greater lifetime income amounts by waiting until they reach age 66 or even 70. While this can be a gamble, it is usually the most prudent choice to make.

If you decide to claim your benefit early at age 62, you will receive a smaller check for a longer period of time. If, however, you claim later at 66 or 70, you will receive a larger check for a shorter time period. Ages 78 to 80 are often called the break-even age. If you assume that you and/or your spouse might live beyond these ages, then it could make sense for you to claim Social Security at a later age. Some statistics show that for a healthy married couple age 65, at least one person has a 50% chance of living to age 92.1

Tool #3: If Married, Harness Your Living Spousal Income Benefit

Married couples, in particular, can employ creative strategies to maximize their lifetime Social Security income. To do this, you must pay close attention and learn the rules. For example, you should consider the often overlooked, yet powerful benefit, called the “spousal income benefit.” Understanding how this benefit works and correctly applying it in Social Security income planning can be a significant generator of additional income for a couple.

For example, a spouse with a low earnings history, or a spouse who never worked, can collect up to one-half of the primary earner’s (i.e. spouse with the highest benefit) Social Security income. Had this lower-earning spouse filed on his/her own record, he/she might receive very little, and in some cases, no Social Security income. Please note that there are some rules, caveats, and exceptions that apply to the spousal benefit. Make sure to contact a qualified Financial Advisor to assist you with understanding this benefit and how it might apply to you.

Also, very few Social Security claimants or even financial counselors, are aware you can switch from the spousal benefit to your own benefit or vice-versa. Properly activating and timing the spousal income benefit is an important part of maximizing your Social Security income. Correctly timing the use of this benefit becomes a function of each spouse’s age, their Social Security earnings’ history, and the optimal time to implement the benefit. Once again, consult a qualified Financial Advisor for details on these spousal switching rules.

Couples will often neglect planning for their Social Security income benefit in the context of the survivor benefit. Women typically outlive their spouse by 3 to 4 years. And, they often face longer periods of disability than men during the latter years of their lives. These prolonged periods of disability (e.g. expensive, chronic nursing care) can result in significant financial duress to the surviving spouse.

As discussed earlier, studies show that for a couple age 65, at least one person has a 50% chance of living to age 92. Furthermore, at least one spouse has a 25% chance of living to age 971, typically the female.

Following the death of a spouse, the survivor receives one Social Security income check instead of two. In some instances, the survivor’s employment pension income might be reduced or altogether eliminated. Therefore, it is critical for the surviving spouse to maximize his or her Social Security survivor benefit to make up for these potential income reductions.

One benefit of Social Security is that when a spouse passes on, the other spouse will “bump-up” to that spouse’s benefit if it is higher than his or her own benefit. Typically, for the survivor to capture the highest Social Security income benefit, it is advantageous to have the spouse with the higher Social Security income benefit delay claiming benefits until age 70.

A spouse can potentially drastically “short-change” his/her surviving spouse by taking Social Security early. For example, let us say Jim decides to claim at age 62 for $1,725 per month. If Jim waited until age 70, his income amount would step up to about $3,036 per month, a 76% increase above his age 62 amount.

So let us go ahead and include two claiming scenarios. First, we assume Jim and Linda are the same age. Second, we further assume Jim dies at age 77, and Linda lives to 93. Jim receives $1,725 a month if he claims Social Security at age 62 and $3,036 if he claims at age 70. If Jim claims at age 62 and dies at 77, then Linda would receive $1,725 monthly for the rest of her life. However, if Jim waits and claims at age 70, Linda would receive about $3,036 per month. This represents an increase of $1,311 a month, which is substantially more than if Jim had claimed at age 62. Furthermore, if Jim claims at age 70, versus age 62, Linda would receive an additional $251,712 of income during her 16 years of widowhood.

In summary, the survivor benefit is a substantial planning consideration that should not be ignored. The survivor’s benefit is especially important to females, because they typically outlive their male counterparts. Planning for a strong survivor benefit is a significant part of comprehensive, intelligent Social Security income planning for married couples.

Tool #5: Work with a Social Security Specialist to “Do the Math” to Determine Your Best-fit Claiming Strategy

Few financial professionals are fluent and experienced in the art of Social Security income planning. Accountants and tax professionals are often focused on traditional practice areas, such as tax preparation, tax auditing, and bookkeeping. The vast majority of Financial Advisors work primarily in the area of investment management and administratively maintaining client relationships.

Social Security administration personnel are typically involved with helping the public with information requests, case management, and routine claiming requests. The local Social Security staff is typically not allowed to provide customized financial advice or to suggest case-by-case Social Security optimization financial planning recommendations.

It is essential that you make the effort to locate an advisor who specializes in Social Security income planning. He or she will help you understand the concepts and tools put forth in this report. An advisor specializing in Social Security planning will have dedicated software to help you evaluate the hundreds of Social Security income claiming possibilities to help you get more income. Contrary to what you might assume, Social Security income planning is an emerging area in the financial services. And the rules for electing Social Security have been changing. Consequently, it is to your advantage to take some extra time to find a qualified Social Security planning professional who can help you with your decision.

A significant portion of pre-retirees and early retirees do not “do the math” to make the optimal Social Security income decision for their unique situation. Many are not aware that these Social Security claiming strategies even exist. Others are not aware of and are not counseled by a Financial Advisor who is familiar with how to maximize Social Security income. Failure to examine and implement these advanced claiming strategies can result in a significant reduction in lifetime income for many retirees.

There are compelling financial income incentives for applying some of the advanced claiming strategies. Depending on a couple’s Social Security “vitals” (earnings history, relative ages, and life expectancy) and your goals, they may wish to apply claiming strategies such as the “File & Suspend,” or “Claim Some Now, Claim More Later.” A detailed description of these strategies is beyond the scope of this article. In short, these strategies all involve the timing of filing for benefits and utilization of the spousal and survivor benefit concepts described earlier in this report to maximize lifetime income.

A significant portion of those who claim Social Security execute the “land grab” strategy and take it as soon as possible at age 62. Others partially understand the potential merits of waiting and claim later at age 66 or 70. Those of you who become educated and carefully apply these advanced claiming strategies may be rewarded with significant additional retirement income over your lifetime.

Tool #6: Orchestrate Your Social Security Election Plan in the Context of Your Retirement Income Stream and Investment Holdings

Some Social Security claimants think their Social Security income is, or will be, tax-free. For many, this may not be the case. Up to 85% of your Social Security income may be taxable due to what is called provisional income.2 Provisional income, according to Kevin McCormally of Kiplinger, is “… basically your adjusted gross income plus any tax-exempt interest, plus 50% of your Social Security benefits.”

Several sources of income can contribute toward triggering the provisional income taxation thresholds for you. These income sources may impact the taxation of your Social Security income benefit. These income sources include, but are not limited to:

Distributions from your 401k or IRA account(s)

Wages, pension income

CD, money market, savings interest

Dividends from stocks, bonds, mutual funds

Of course, you will want to be mindful and minimize the taxation of your Social Security benefit if possible. Therefore, it is important to investigate and determine in which sequence you might draw upon your retirement income stream and/or retirement asset buckets. When and how you take your Social Security income can significantly enhance or reduce the longevity of your retirement assets and income stream. Questions you might consider asking yourself include:

Should I take Social Security early or later?

Which Social Security income election strategy will give me the most lifetime income?

Does it make sense for me to first draw upon my 401k and/or IRA account(s) and then claim Social Security later?

Does it make sense to re-distribute some of my assets into other investment vehicles that minimize, or altogether possibly eliminate, the taxation of my Social Security benefit?

Next Steps and the consultative Process

In summary, the Social Security income election decision should not be made in a vacuum. The concepts and considerations highlighted in this report uncover many important elements necessary to maximize your Social Security income election.

You should strongly consider working closely with a financial professional who has the experience and tools to guide you through the Social Security income election maze. He or she should also be able to help you synchronize your Social Security income election with your bigger picture retirement income plan. Your Social Security income election is one of the most important money decisions you may make in your lifetime, so you will want to do everything possible to get it right.

1 Source: Annuity 2000 Mortality Table, Society of Actuaries. Figures assume you are in good health.

2 This article may contain tax and tax planning discussion/examples that should be reviewed by your personal tax and/or legal advisor to determine if they are appropriate for your particular situation and comply with local law. River Wealth Management, LLC does not render legal advice.

Michael K. Harris is the CEO of River Wealth Management, LLC. The firm provides portfolio management services through Interactive Brokers and Motif Investing, Inc. Mr. Harris does not represent Interactive Brokers or any other broker/dealer. Michael has series, 7 and 66 securities licenses, holds a BSBA in finance from Auburn University, and has served the river region with local and national financial services firms since 1980.

River Wealth Management, LLC is a fee only Registered Investment Advisor. Our clients demand . . . and we deliver the highest level of integrity, transparency, and local values in every client relationship. We do not sell financial products. We provide objective, conflict-free advice and portfolio management services.

Mike assists his clients and educates other professionals with financial planning and retirement transition issues such as Social Security income planning, institutional and individual portfolio management, retirement planning, portfolio diversification, . . . Mike’s primary specialties are helping families optimize their Social Security Income election & effectively managing their 401k, IRA, and nest egg retirement assets and income sources.

Thank you Prattville! I very much appreciate the folks who showed up at our ribbon cutting to show their support for me, my family, and River Wealth Management. It is an honor and privilege to serve you! Great pics taken by Donna Jackson.